EUR eyeing ECB decision

Will they or won’t they? Following the slightly higher than expected January CPI inflation reading and some improvement in economic data such as the Feb PMI manufacturing survey earlier this week expectations for policy easing by the ECB today have diminished. Consequently the EUR has been well supported above 1.3700 even in the face of growing conflict on its doorstep in Ukraine. The risk / reward today is therefore skewed to a bigger EUR (negative) reaction if the ECB does act to ease policy, a possibility that the market may not be giving sufficient credence too. For what it’s worth 3m interest rate futures and 2 year US – Eurozone yield differentials suggest that EUR/USD is overbought.

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CNY / CNH pressure continues

CNY/CNH the downward pressure is unlikely to abate in the near term. The desire to 1) implement two way risk, 2) higher volatility and 3) curb strong capital inflows 4) prepare for band widening, will not end quickly. A resumption of a strengthening trend in CNY / CNH will undo these aims quickly as inflows resume. Hence, if China really wants to instigate significant volatility in the currency the weakening trend is set to continue for a while to come.

At what level does the weakness in the CNY stop? Well my quantitative model already suggests that USD/CNY has already overshot its short term fair value (6.0904) but the bottom line is that this overshoot may persist for several weeks. Nonetheless, CNY has reversed all of its strength versus USD from early October and further weakness may be less rapid.

Further out, the CNY is likely to resume a stronger tone but this may be some weeks away. China continues to benefit from large foreign exchange reserves and a healthy external balance and this will eventually result in upward pressure on the currency. A move back to around 6.00 versus USD by year end remains likely but China’s authorities will want to ensure that the market does not believe that the path there will be a one way street.

Remaining constructive on AUD

In contrast to the consensus view I remain rather constructive on the AUD. As reflected in the RBA minutes today the central bank has shifted its stance somewhat, effectively closing the door on further policy easing while finding it difficult to talk the currency lower as inflation pushes higher.

Separately although Chinese growing is slowing this year assuming that growth does not fall too far and too quickly the AUD is unlikely to suffer much from this source.

A lot bad news for AUD has been largely priced in. Firstly, the drop in AUD/USD has been consistent with the deterioration in terms of trade.

Secondly Australia’s broad basic balance position is quite healthy as strong direct investment and portfolio inflows counter a current account deficit.

Thirdly, even when looking at China’s growth trajectory the AUD is at a level which discounts this. Near term resistance for AUD/USD is seen around 0.9087.


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US dollar soft ahead of retail sales

The USD has lost a fair bit of ground in February failing to benefit from a renewed rise in US Treasury yields. A more positive risk environment recently has undermined some of the demand for USDs while some negative data surprises such as the ISM manufacturing survey and non farm payrolls have also weighed on demand for the USD.

The release of January retail sales data today will give another opportunity to gauge the path of consumption at the turn of the year but unfortunately for the USD a relatively flat outcome for sales will provide little rationale to buy the currency. The consensus expectation is for headline retail sales to post a 0% monthly reading, while sales ex autis is likely to rise by a measly 0.1%.

In the near term this implies little potential for a USD rebound but over but over coming weeks I expect the USD to rally in line with higher US yields. USD index (DXY) is likely to flatline around the 80 level in the coming sessions before rallying over coming weeks.

USD/JPY biased higher within a tight range

After hitting a low around 101.77 yesterday USD/JPY rebounded. USD/JPY short term range is seen at 101.62-103.58. Bias for more short term USD/JPY upside. The bounce in US 10 year Treasury yields overnight will give the USD some support versus JPY.

A combination of a sharp decline in US Treasury yields (narrowing the yield differential with Japan) and elevated risk aversion (my risk barometer has breached its upper band) had pushed the JPY higher.

The close to 30 bps drop in US 10 year yields since the start of the year looks excessive however, and assuming the Fed continues to taper at tomorrow’s FOMC meeting I see little reason for US bond yields to drop much further, suggesting more limited scope for JPY upside versus USD from current levels.

The only caveat is risk aversion. Given that emerging market tensions are unlikely to ease quickly there will be scope for sharp bouts of safe haven JPY buying as risk aversion intensifies.

Lower US yields undermine the US dollar

A drop in US yields has undermined the USD over recent days against major currencies although emerging market currencies remain under varying degrees of pressure. US 10 year Treasury yields have fallen by around a quarter of a percent since the end of last year, acting as a real drag on the USD.

A rise in risk aversion over recent days (the VIX fear gauge has risen by over 13% since its low on 10 January) appears to have resulted in increased demand for Treasuries and weaker equities, with markets ignoring generally firmer than anticipated US economic data this week including weekly jobless claims and existing home sales.

Emerging market currencies have come under strong pressure while the usual safe havens have strengthened most against the USD in particular CHF and JPY. The EUR has also made up some ground. Fortunately for the USD expectations of Fed tapering continue to fuel some buying of the currency, constraining any downside. Nonetheless, until US Treasury yields resume their upward movement the USD’s upside momentum will be limited.

USD/JPY pulls back, AUD range bound

USD/JPY pulled back sharply overnight dropping swiftly below 105 as weaker global equities / higher risk aversion together with a pull back in US yields weighed on the currency pair. Nonetheless, its pull back is set to prove temporary and if anything provides better levels to initiate long positions. A Japanese holiday today will limit the scope for much movement in the currency.

Japan clearly has a lot of policy challenges in the months ahead (consumption tax hike, Prime Minister Abe’s third arrow, and hitting the 2% inflation target) which could prompt some volatility in the JPY but the risks remain skewed for more downside in the currency, especially given the potential for more aggressive BoJ policy action and of course the likelihood that the real yield differential between the US and Japan widens further.

AUD was undermined somewhat by the release of weaker than expected Chinese manufacturing and non manufacturing confidence data and softer commodity prices but overall the currency looks like it has found a new range around 0.8820- 0.8980 against the USD over the short term. This relative stability even in the wake of disappointing news in China marks a major shift compared to the selling pressure registered over much of Nov/Dec 13.

I am more constructive on AUD going forward and expect much more limited downside potential in the week ahead. Direction next week will come from trade data, building approvals and retail sales, but movement ahead of this will be limited.

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